Practical analysis for investment professionals
07 November 2014

Weekend Reads for Global Investors: To QE, or Not to QE?

Posted In: Weekend Reads

QE3, or the third round of quantitative easing by the US Federal Reserve, came to an end as expected last week. It turns out that it was not the only headline from QE land, however. Bank of Japan surprised the market last Friday by annoucing an expansion of its current asset purchase program of about 50 trillion yen a year to 80 trillion yen.

The effectiveness of quantitative easing in generating economic growth has increasingly come under question by academics and investors alike. Richard Koo, the prominent economist from Nomura, has long believed that monetary expansion post-recession is far less powerful than fiscal measures in getting the economy back on track. (Watch a video where Richard Koo explained his “balance sheet recession” theory at the CFA Institute Japan Investment Conference this summer.)

The reasoning is somewhat simple at its heart: With asset prices falling after a recession, investors have little incentive to step in and catch the falling knife. So no matter how much money central banks pump into the system, people simply do not want to borrow. This, of course, is drastically different from what typically happens when the economy is heating up: people who already have a house to live in still want to borrow and “invest” in additional housing.

So if it is so obvious, why do central bankers start the QE programs in the first place? The answer is to save us from a 1930s-like depression and the pain it inflicts on normal people’s lives. On that point, there tends to be little argument, whether in academic circles or among practitioners.

The divide comes after the initial rescue, and here’s the Weekend Reads’ version of it: There have been two main camps of macro-economists — the Keynesians and the monetarists. People with a lot of grey hair may still remember something called the “liquidity trap,” a term Keynes invented some 80 years ago. It basically describes a situation when demand falls far short of supply in the economy, adding “liquidity” (i.e., conduct QE programs in today’s terminology) alone won’t be enough to push the economy back to normal. The monetarists believe, in the words of Milton Friedman, “inflation is always and everywhere a monetary phenomenon.” So to reflate the economy, pump money into the system.

I won’t ruin your weekend by going into how monetarists have gotten the upper hand in recent decades and made QE the default choice at the height of the global financial crisis and in the years after. (If you really want to know, by all means leave us a note in the comments section and we’ll cover it in a Weekday Reads for you.) And the point of academic debates is probably moot from most people’s perspective.

All you need to ask yourself is, are you better off after QE2, QE3, and the like?

To QE, or Not to QE?

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

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About the Author(s)
Larry Cao, CFA

Larry Cao, CFA, senior director of industry research, CFA Institute, conducts original research with a focus on the investment industry trends and investment expertise. His current research interests include multi-asset strategies and FinTech (including AI, big data, and blockchain). He has led the development of such popular publications as FinTech 2017: China, Asia and Beyond, FinTech 2018: The Asia Pacific Edition, and Multi-Asset Strategies: The Future of Investment Management and is a frequent speaker at industry conferences on these topics. During his time in Boston pursuing graduate studies at Harvard and as a visiting scholar at MIT, he also co-authored a research paper with Nobel laureate Franco Modigliani that was published in the Journal of Economic Literature by American Economic Association. Larry has more than 20 years of experience in the investment industry. Prior to joining CFA Institute, Larry worked at HSBC as senior manager for the Asia Pacific region. He started his career at the People’s Bank of China as a USD fixed-income portfolio manager. He also worked for US asset managers Munder Capital Management, managing US and international equity portfolios, and Morningstar/Ibbotson Associates, managing multi-asset investment programs for a global financial institution clientele. Larry has been interviewed by a wide range of business media, such as Bloomberg, CNN, the Financial Times, South China Morning Post and the Wall Street Journal.

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